Diversification

Don't put all your eggs in one basket

Diversification helps you ride out the ups and downs of
financial markets by spreading your money across different asset
classes. It will leave you less exposed to a single economic event,
so if one business or sector you've invested in isn't performing
well, you won't lose all your money .

How diversification works

Diversification won't guarantee gains or protect against losses,
it's about managing the risk/reward trade off by selecting a mix of
investments to help you achieve more consistent returns over
time.

Assets that carry a higher risk should deliver a higher reward
but are also likely to have more volatile returns over the
short-term. You can offset some of this risk and volatility by including assets that have
lower risk and return but lower short-term volatility.

In addition, markets for different asset classes peak at
different times, which means when returns for one asset
class are high, returns for a different asset class may
be low. By having your funds spread across a number of different
investment types, your overall returns will be less volatile as low
returns or losses on one investment are offset against high returns
or gains on another.

Sometimes things don't go according to plan and occasionally a
company you have invested in will make a loss or fail completely.
If you are well diversified and have limited your exposure to any
single asset you will be less likely to suffer a big loss if this
happens.

Read our booklet

How to diversify

To create a diversified portfolio start by investing across
different asset classes. An ideal investment portfolio will include
some investments that have a higher risk and reward (growth assets)
and some investments with a lower risk (defensive assets) and
reward. The proportion of each type of asset will depend on your
investment time frame and your personal risk tolerance. See goals
and risk tolerance and choose your investments for
more information.

Once you've considered the major asset classes; cash, fixed
interest, bonds,
property and shares, think about
diversifying further by choosing different sectors within each
asset class.

Don't forget to take into account lifestyle assets you may
already have. For example, if you already own (or are paying off) a
home, using all your money to buy another residential property
would be an example of poor diversification.

When adding to your investment portfolio, consider whether the
investment will further diversify your portfolio or whether you are
concentrating your funds into a single asset class.

Invest in different industries

Different asset classes perform better at different times, as do
industry sectors within an asset class. Figure 1 shows how
different sectors of the Australian share market have performed
over time. The materials and healthcare sectors have been more
volatile than other sectors and the ASX200 overall.

Figure 1: Sectors of the Australian Sharemarket (1 April 2000 -
27 February 2018)

Loading graph...

Source:
Bloomberg.

Invest in different markets

Australia has a relatively small share of the world's investment
opportunities. Investing some of your money overseas will reduce
your exposure to a single market. Different markets will also peak
at different times, for example, Asian or US markets might be up
when Australian markets are down.

Be aware that when you invest in international markets you have
the added risk that changes in currency exchange rates can increase
or reduce your investment returns.

You can invest in overseas markets directly or through an
overseas share option in a managed fund, ETF or super fund. Seek financial
advice if you need help getting started or managing the
risks.

Spread your timing

'Timing risk' is the chance that your investments will suffer
because of when you buy or sell your investments. For example, you
buy an investment just before a big price drop, or sell just before
the price goes up.

Investing at regular intervals, such as monthly or quarterly,
will reduce timing risk. Similarly, selling investments in stages
can reduce timing risk, if it suits your needs.

Diversification within managed
funds and super

Investing through a managed fund or exchange-traded fund is
often the easiest way to access a broad range of investments. The
same principles apply to super funds.

Funds will usually offer a range of investment options, managed
by various investment managers.

Different investment fund managers have different
styles of investing. Rather than relying on one investment manager,
funds may employ a number of investment fund managers to manage
specific parts of a given portfolio. Thisallows you
to benefit from the expertise of a number of managers within one
product.

Investments may include single sector options such as cash,
shares or property, as well as pre-mixed options offering a mix of
investments from different asset classes.

You don't need more than one fund to be diversified. Having 2
managed funds or 2 super funds could just mean you are paying an
extra set of fees. If you have chosen an investment option that
uses multiple investment managers over different asset classes you
will be diversified.

Both funds may even be using the same investment managers
so unless you have chosen multiple funds because they are investing
in very different assets, focus on diversifying within a fund
rather than having multiple funds.

SMSFs

If you have a self-managed super fund
(SMSF), you are responsible for making investment decisions for
that fund. Think carefully about your mix of investments and how
appropriate the mix is in terms of your risk tolerance and your
fund's primary purpose of accumulating funds to live off in
retirement.

Follow the same principles of diversification and don't be
tempted put all your money in any one sector of the market, for
example property, if that that is not in line with the fund
objectives. See SMSFs and property for more
information.

How to keep your investments
diversified

Once you have a mix of investments that meet your needs, keep it
on track with regular check-ups and rebalancing.

Review your investments regularly

How often you review your investments will depend on the type of
investments you have. If you have invested in a type of managed
fund, an annual review to make sure the fund returns ae in line
with expectations and that the investment mix is still appropriate
for your needs, may be sufficient.

If you have invested in direct investments, such as shares, you
will need to review your investments much more frequently, and keep
an eye out for any news or company announcements that may affect
your investments.

Investment returns can alter the percentage mix of your
investment portfolio over time. If your investment mix moves away
from your target by more than 10% you may want to consider
rebalancing your portfolio, to maintain your desired level of
different asset classes.

How to rebalance

You can rebalance your portfolio by selling assets you currently
have too many of and reinvesting the proceeds in types of assets
that fall short of your target allocation. Selling may have
tax consequences, so be sure to consider this before making
any decisions to sell. See make tax work for you for more
details.

Another way to rebalance without immediate tax consequences is
to invest any extra money you might have (such as ongoing
contributions or your yearly bonus), in asset classes that are
currently below your target allocation.

Diversification is about spreading your
investments over a range of assets, managers and markets.
Diversification will not ensure against loss, but will help even
out returns over your portfolio as a whole by reducing overall
volatility.